Corporate Profits = Greed?

Is it somehow immoral for a corporation to earn a profit?  Too many people think that it is these days.  I don't see much evidence that anyone in America or anywhere else thinks that high profits are a good thing.  Is that right?  What are the benefits of high profits?

• Employees' jobs are secure
• Employees' are more likely to get a raise and good benefits
• The corporation has generally got good cash flow, and that provides
• cash to invest in new products and R&D
• cash to invest in new equipment for better quality and lower cost products
• cash to pay the obligations and prevent bankruptcy
• The corporation pays more taxes to keep the government solvent (or at least it will help delay national bankruptcy)
• When the corporation invests in new plants and buildings and equipment, other companies sell more of these things and become more profitable, leading to
• lower unemployment
• more taxable profits

What determines how profitable a company can be?  I know you've been told that they earn excess profits because they are jacking up the sell prices of their stuff.  Of course, it's not quite that simple.  We have all heard earnings reports from various large companies saying that they "lost millions or billions of dollars last quarter or last year."  If excess profits are as easy as jacking up the price, why don't the morons running these other companies just jack up their prices and rake in the dough?  The next time you hear someone complaining about some corporation making too much profit, think about how illogical that concept is.  You could try explaining it to them, but you are likely to just get in a big argument that neither of you can win.  Why bother getting all worked up in a pointless effort?

Anyway, let's get back to the subject at hand.  What determines profitability in a corporation?  The profit is very simply the value delivered to the customer minus the cost of delivering it.  That is a fairly simple concept to grasp, although there are some intricacies you may not have considered.

• A product isn't valued the same by all consumers.  Does a soccer mom with three kids value a 4-wheel drive pick-up truck the same as a construction worker?
• Some people see products as having high or higher value than the sell price, yet they don't have the means to afford something that expensive.  For example, you might think a Mercedes Benz is well worth the $60,000 it costs, but you only earn $30,000/year.
• In most industries, you have multiple similar products to choose from, and they are made by multiple competing companies.  If you want to buy a sedan, think of all the makes and models available.  There are also multiple dealers from which to purchase the car.  They may have similar features and prices.  All the competition and choices in the marketplace help the consumer develop a value for a particular product relative to the other alternatives.  For instance, you might like the features of a Honda and a Chevrolet about the same, but you value the Honda a little more highly because of reliability.
• There are many attributes to consider when a consumer decides on the relative values of the choices available.  With cars, there is styling, power, luxury features, reliability, initial quality, handling, roominess, warranty, and dealer service and reputation.
• Sometimes there are competing technologies.  For instance, cars can be purchased with a standard gasoline powered internal combustion engine, a diesel powered internal combustion engine, a plug-in electric vehicle, or a gasoline-electric hybrid.
• There are generally choices between whole competing markets.  If you live in New York City, you don't need to buy a car.  You can probably take public transportation around the city.  With that you have a choice of a bus, a subway train, or a taxi.  If you go out of the city, you can ride on Amtrak, a bus line, an airplane, or you can rent a car and drive.

Most people have at least some understanding of the laws of supply and demand.  Let's look at the demand side first.  If some people value a product being sold at least as much as the sell price, they will want to buy it, and that is demand.  Looking at the supply side, if the sell price is higher than the cost of production, manufacturers will want to supply the product because it earns them a profit.  If profits are really high, companies already making the product will be happy to invest in more equipment and increase their production rates.  Also, other companies may want to develop their own competing products to participate in this profitable market.  Of course, as supply of the product increases, more consumers will need to be induced to make a purchase.  Since different consumers value it differently, reducing the sell price will induce more consumers to purchase it, because more will find that the value they see in the product is at least as high as the price.  Thus, shifting the supply curve up will reduce the price in order to ride up higher on the demand curve.  What causes the supply curve to shift up?  That's right, high profits -- you know the ones that are considered excessive.

The intersection of the supply and demand curves is the point of equilibrium where the quantity being supplied equals the quantity demanded.  Setting the price higher than equilibrium will lead to excess inventories.  Setting it too low will result in shortages, and the consumer will find that it is out of stock.

Maybe you're thinking that this is a little more complex than you thought at first.  There's a lot more to the story than just this though.  For example, most people think that manufacturing cost is a simple sum of the materials and the labor hours x hourly wage rate of the workers required to make the product.  That would only take the direct cost into account though.  There is also indirect cost, which is sometimes referred to as burden or overhead.  Generally, most of these costs are fixed costs that occur whether you make one or one thousand of the items.  For instance, you have to pay rent on the factory every month, regardless of production rates.  What are some other fixed costs?  Here are a few:

• Lighting, Heating
• Management Salaries
• Sales Salaries
• Cost of Various Support Departments like Human Resources, IT, Accounting, Product Development & Engineering, Warranty & Repair
• Mowing the Grass, Clearing Snow from Parking Lots
• Depreciation of Equipment

These fixed costs must be allocated per unit of production.  That means you take all of the fixed costs and add them up, and then divide that number by the number of units you built.  The answer is the fixed cost/unit.  If you don't make very many parts, the fixed cost per unit is much higher than if you make a whole lot of them.

If you think about it, just raising the price won't necessarily make profits go up at all.  Raising prices will drive down the number of units sold, so the fixed cost/unit will rise.  At least that is true unless you can shut down a plant and shed those fixed costs.  There is a price that will maximize profits, and business schools train their students to figure out what price will lead to the sales volume that will maximize profits.

I learned this in a state supported university.  So why were these government employees training me to maximize profits, while the MessAPolitico and the media and all the little liberals out there are calling business people greedy for doing it the best it can be done?  Of course, if the MessAPolitico would just stay out of the way, the market will always drive profits back down to minimum acceptable levels.  If there are excess profits in an industry, businesses will be enticed to raise production rates until the excess supply drives the price down and profits are just acceptable.  So let's get off this kick of knocking businesses that are successful.  After all, they provide good jobs, quality products that are in demand, and most of all, good value.  If you get a great product that satisfies your needs at an acceptable price, who cares how profitable the manufacturer is?